The asymmetric effect of the business cycle on the relation between stock market returns and their volatility
نویسنده
چکیده
We examine the relation between US stock market returns and the US business cycle for the period 1960 2003. We identify two channels in the transmission mechanism. One is through the mean of stock returns via the equity risk premium, and the other is through the volatility of returns. We find that the relation is asymmetric with downturns in the business cycle having a greater negative impact on stock returns than the positive effect of upturns. These results are based on a new model of the relation between returns and their volatility derived from the stochastic discount factor model of asset pricing. This model encompasses CAPM, consumption CAPM and Merton’s (1973) inter-temporal CAPM. It is implemented using a multi-variate GARCH-in-mean model with a time-varying conditional heteroskedasticity and correlation structure.
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